ESTATE PLANNING FOR AN IRA (After 2019)
(This Article only applies to IRAs inherited after 2019)
Surviving spouses can roll IRAs that they inherit from a deceased spouse into their own accounts, postponing required minimum distributions - and taxes - until they turn 72. Children and other beneficiaries do not have that option. If the children or other beneficiaries want to continue to benefit from tax-deferred growth, each must roll his/her portion of the IRA into a separate account known as an “Inherited IRA”, which comes with its own set of rules.
To give your children or other beneficiaries the option to establish an Inherited IRA account, you must name them, or a qualified trust, as beneficiaries of the IRA. Many spouses name each other as beneficiaries, and after one spouse dies the survivor names the estate as the beneficiary. That may seem like the logical approach if your children are the beneficiaries of your estate. But although your children will still inherit the money, they will be required to completely withdraw the IRA balance by the end of the 5th year after your death. If you name your children or other beneficiaries, or a qualified trust, as beneficiaries of your IRA (or as secondary beneficiaries if your spouse is still alive), and you die after 2019, you give your children or other beneficiaries an additional 5 years to stretch out the distributions from their Inherited IRA, as your beneficiaries will have 10 years to completely withdraw the entire IRA balance. Beneficiaries can withdraw any amounts they wish during these 10 years, which provides beneficiaries with some planning flexibility during these 10 years to withdraw funds when it best fits their income tax situation.
There are exemptions for certain beneficiaries called “eligible designated beneficiaries”, or EDBs. Eligible designated beneficiaries are: (1) surviving spouses; (2) minor children, up to majority-but not grandchildren; (3) disabled individuals-under strict IRS rules; (4) chronically ill individuals; and (5) individuals not more than 10 years younger than the IRA owner (generally siblings around the same age). These individuals are able to stretch out the distributions under distribution rules in effect prior to 2020 for as long as the beneficiaries still qualify as EDBs. Once the beneficiary is no longer an EDB, they are then subject to the 10-year rule.
A Roth IRA inheritance is usually tax-free, but the same rules for withdrawals apply. If your beneficiaries transfer the funds to accounts for Inherited Roth IRAs, they can plan their withdrawals over 10 years. However, if you name your Estate as the beneficiary, full distribution is required by the end of the 5th year after your death. (Note that the exemption rules for eligible designated beneficiaries (EDBs) also apply to Roth IRAs.)
Special Rules for Beneficiaries of Inherited IRAs. Your spouse may transfer the funds directly into his/her personal IRA, or may transfer the funds into a separate “Inherited IRA” account. However, the beneficiaries must have funds transferred directly from your IRA into a separate Inherited IRA account. If a beneficiary receives checks made out to them personally, they will be prohibited from depositing the funds into an Inherited IRA and will have to pay taxes on the entire amount. There is no 60-day window for a beneficiary to rollover an inherited IRA into a new inherited IRA account. Once the money is safely in the Inherited IRA account, your beneficiaries have 10 years to completely withdraw the entire IRA balance, unless the beneficiary is an “eligible designated beneficiary” (see above).
Your beneficiaries can cash out the account at any time without paying an early withdrawal penalty, even if they are not yet 59 ½. However, unless they inherit a Roth IRA, they will have to pay taxes on the money (except to the extent, if any, that the original IRA holds nondeductible contributions). A large withdrawal could push the beneficiary into a higher tax bracket.
Ignoring non-person beneficiaries. IRAs with multiple beneficiaries that include a charity or other non-person entity must pay out that entity’s share by September 30 of the year following the owner’s death. If that share is not paid out and the account has not been split, the qualified beneficiaries cannot take withdrawals over 10 years. The qualified beneficiaries would have to complete all distributions from the account within 5 years.
If a trust is a beneficiary, the trustee needs to send a copy of the trust to the IRA custodian by October 31 of the year following the year the owner died. Otherwise, the trust is considered a non-designated beneficiary and the same payout rules that applied in the previous scenario with the charity will kick in.
The above is a summary of the general rules for IRAs. You should not rely on this advice as each person’s plan requires review for advice that would apply to their situations. Additionally, the rules and laws may change. You should consult with your tax or estate planner on a regular basis for current information and advice.